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OLBK > SEC Filings for OLBK > Form 10-K on 14-Mar-2014All Recent SEC Filings

Show all filings for OLD LINE BANCSHARES INC

Form 10-K for OLD LINE BANCSHARES INC


14-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

We operate a general commercial banking business, accepting deposits and making loans and investments.

In an economic and regulatory climate that continues to present challenges for our industry, we are pleased to report significant strategic accomplishments during the year and continued profitability. Net income available to common stockholders, after inclusion of $3.5 million in merger and integration expenses, was $7.8 million or $0.87 per basic and $0.86 per diluted common share for the year ending December 31, 2013 which represented a 4.10% increase over the prior year's net income available to common stockholders of $7.5 million.

The following highlights contain financial data and events that have occurred during 2013:


The merger with WSB became effective May 10, 2013, causing total assets to grow to $1.2 billion at December 31, 2013 compared to $861.9 million at December 31, 2012.


$12.2 million of new capital was successfully raised through a private placement of 936,695 shares of common stock at a price of $13.00 per share.


Net loans increased $254.1 million or 42.70% during the year ended December 31, 2013, to $849.3 million at December 31, 2013 compared to $595.1 million at December 31, 2012, as a result of organic growth and the acquisition of WSB.


Non-interest bearing deposits increased $39.8 million or 21.09% during the year ending December 31, 2013. Interest bearing deposits increased $199.1 million during the year compared to the balance at December 31, 2012, primarily as a result of the acquisition of WSB and partially offset by the planned reductions in higher cost deposits.


Net income was $7.8 million or $0.87 per basic and $0.86 per diluted share for the year ended December 31, 2013 compared to $7.5 million, or $1.10 per basic and $1.09 per diluted share, for 2012.


For the year ended December 31, 2013, Return on Average Assets (ROAA) and Return on Average Equity (ROAE) were 0.74% and 7.80%, respectively, compared to ROAA and ROAE of 0.90% and 11.17%, respectively, for the year ended December 31, 2012.


The net interest margin was 4.53% during 2013 compared to 4.65% for 2012. Re-pricing in the loan portfolio and slightly lower yields on new loans caused the average loan yield to decline.


Of note, we entered the residential lending business through the WSB acquisition.


We ended 2013 with a book value of $11.71 per common share and a tangible book value of $10.50 per common share.


We maintained liquidity and by all regulatory measures remained "well capitalized."

Additionally, the following branch developments occurred during 2013:


On March 29, 2013, we closed our branch located at 12080 Old Line Centre, Waldorf, Maryland. In conjunction with this closure, we disposed of all of the fixed assets that we did not transfer to another location and accelerated the remaining lease payments due under the lease agreement for this location. We transferred the deposits of this branch to one of our other two Waldorf locations. The closure of this facility eliminates approximately $250,000 in annual non-interest expense.


During the first quarter of 2013, we opened a loan production office located at 12501 Prosperity Drive, Suite 215, Silver Spring, in Montgomery County, Maryland. We have hired a Senior Vice


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President with over 30 years of banking experience to lead this office. This office will allow us to continue to expand our services to the Montgomery County market. We anticipate that the individuals in this office will generate sufficient interest and non-interest income during 2014 and beyond to more than offset the cost associated with this office.

Strategic Plan

We have based our strategic plan on the premise of enhancing stockholder value and growth through branching and operating profits. Our short term goals include collecting payments on non-accrual and past due loans, profitably disposing of certain acquired loans and other real estate owned, enhancing and maintaining credit quality, maintaining an attractive branch network, expanding fee income, generating extensions of core banking services, and using technology to maximize stockholder value. During the past few years, we have expanded organically in Montgomery County, Prince George's County and Anne Arundel County, Maryland. The acquisition of WSB Holdings will continue to further enhance our presence in Charles, Prince George's and Anne Arundel Counties.

We use the Internet and technology to augment our growth plans. Currently, we offer our customers image technology, Internet banking with on line account access and bill payer service. We provide selected commercial customers the ability to remotely capture their deposits and electronically transmit them to us. We will continue to evaluate cost effective ways that technology can enhance our management capabilities, products and services.

We may take advantage of strategic opportunities presented to us via mergers occurring in our marketplace. For example, we may purchase branches that other banks close or lease branch space from other banks or hire additional loan officers. We also continually evaluate and consider opportunities with financial services companies or institutions with which we may become a strategic partner, merge or acquire such as we have done with Maryland Bankcorp and WSB Holdings.

Although the current economic climate continues to present significant challenges for our industry, we have worked diligently towards our goal of becoming the premier community bank in the Washington, D.C. market, resulting in increased penetration into the Charles, Prince George's and Anne Arundel County markets through the new branches we acquired in the WSB acquisition. While we are uncertain about the pace of economic growth or the impact of the current political environment, and we believe that high unemployment and growing national debt will continue to dampen the economic climate, we remain cautiously optimistic that we have identified any problem assets, that our remaining borrowers will stay current on their loans and that we can continue to grow our balance sheet and earnings. We believe that we are well positioned to capitalize on the opportunities that may become available in the current economy as well as a healthier economy.

If the Federal Reserve maintains the federal funds rate at current levels and the economy remains stable, we believe that we can continue to grow total loans and deposits during 2014. We also believe that we will be able to maintain our current level of core net interest margins during 2014. As a result of this growth and expected continued strength in the net interest margin, we expect that net interest income will continue to increase during 2014, although there can be no guarantee that this will be the case.

We also expect that salaries and benefits expenses and other operating expenses will continue to be higher in 2014 than they were in 2013 due to the acquisition of WSB Holdings. We believe with our existing branches, our lending staff, our corporate infrastructure and our solid balance sheet and strong capital position, we can continue to focus our efforts on improving earnings per share and enhancing stockholder value. Final core conversion with WSB was completed during the fourth quarter of 2013, which caused earnings to be lower than would otherwise be expected. However, the majority of merger-related costs in connection with the WSB merger have been expensed in 2013 and going forward these expenses should be substantially lower.


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Mergers and Acquisitions.

WSB Holdings, Inc. On May 10, 2013, Old Line Bancshares acquired WSB Holdings, the parent company of The Washington Savings Bank, F.S.B. We converted each share of common stock of WSB Holdings into the right to receive, at the holder's election, $6.0743 in cash or 0.557 shares of Old Line Bancshares' common stock. We paid cash for any fractional shares of Old Line Bancshares' common stock and aggregate cash consideration of $17.0 million. The total merger consideration was $54.7 million based on recent trading prices of Old Line Bancshares' common stock at the time of the merger.

In accordance with accounting for business combinations, during the second quarter of 2013, we recorded the acquired assets and liabilities of WSB at their estimated fair value on May 10, 2013, the acquisition date. The determination of the fair value of the loans caused a significant write down in the value of certain loans, which we assigned to an accretable or non-accretable discount. We recognize the accretable discount as interest income over the remaining term of the loan. The non-accretable discount will be adjusted based on subsequent increases or decreases to the expected cash flows and will result in either an increase to accretion income or provisions for loan losses, respectively. The accretion of the loan marks, along with other fair value adjustments, favorably impacted our net interest income by $682 thousand for the twelve months ended December 31, 2013.

In conjunction with the merger, we also recorded the deposits acquired at their fair value and recorded a core deposit intangible of $2.4 million. The amortization of this intangible asset decreased net income by $179,642 for the year ended December 31, 2013.

The former WSB franchise is currently operating under the Old Line Bank name.

Maryland Bankcorp, Inc. On April 1, 2011, Old Line Bancshares acquired Maryland Bankcorp, the parent company of Maryland Bank & Trust Company, N.A. We converted each share of common stock of Maryland Bankcorp into the right to receive, at the holder's election, $29.11 in cash or 3.4826 shares of Old Line Bancshares' common stock. We paid cash for any fractional shares of Old Line Bancshares' common stock and aggregate cash consideration of $1.0 million. The total merger consideration was $18.8 million.

In accordance with accounting for business combinations, we recorded the acquired assets and liabilities of Maryland Bankcorp at their estimated fair value on April 1, 2011, the acquisition date. The determination of the fair value of the loans caused a significant write down in the value of certain loans, which we assigned to an accretable or non-accretable discount. We will recognize the accretable discount as interest income over the remaining term of the loan. The non-accretable discount will be adjusted based on subsequent increases or decreases to the expected cash flows and will result in either an increase to accretion income or provisions for loan losses, respectively. The accretion of the loan marks, along with other fair value adjustments, related to MB&T favorably impacted our net interest income by $2.8 million, $3.4 million and $2.2 million for the years ended December 31, 2013, 2012 and 2011, respectively.

In conjunction with the merger, we also recorded the deposits acquired at their fair value and recorded a core deposit intangible of $5.0 million. The amortization of this intangible asset decreased net income by $659,052, $727 thousand and $584 thousand for the years ended December 31, 2013, 2012 and 2011, respectively.

The former MB&T franchise is currently operating under the Old Line Bank name.

Critical Accounting Policies and Estimates

Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. They require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. The following are the accounting policies that we believe are critical. For a discussion of recent accounting pronouncements, see Note 1-Summary of Significant Accounting Policies in the Notes to our Consolidated Financial Statements.


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We prepare our financial statements in accordance with accounting principles generally accepted in the United States of America and follow general practices within the industry in which we operate. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. We base these estimates, assumptions, and judgments on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third party sources, when available.

The most significant accounting policies that we follow are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how we value significant assets and liabilities in the financial statements and how we determine those values. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses as the accounting area that requires the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.

Allowance for Loan Losses-We evaluate the adequacy of the allowance for loan losses based upon loan categories except for delinquent loans and loans for which management has knowledge about possible credit problems of the borrower or knowledge of problems with loan collateral, which management evaluates separately and assigns loss amounts based upon the evaluation. We apply loss ratios to each category of loans, where we further divide the loans by risk rating and apply loss ratios by risk rating, to determine estimated loss amounts. Categories of loans are consumer loans, residential real estate, commercial real estate and commercial loans.

The allowance for loan losses represents management's best estimate of the losses known and inherent in the loan portfolio that are both probable and reasonable to estimate, based on, among other factors, prior loss experience, volume and type of lending conducted, estimated value of any underlying collateral, economic conditions (particularly as such conditions relate to Old Line Bank's market area), regulatory guidance, peer statistics, management's judgment, past due loans in the loan portfolio, loan charge off experience and concentrations of risk (if any). Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant estimates, assumptions, and judgments. The loan portfolio also represents the largest asset type on the consolidated balance sheets.

Management has significant discretion in making the judgments inherent in the determination of the provision and allowance for loan losses, including in connection with the valuation of collateral and the financial condition of the borrower, and in establishing loss ratios and risk ratings. The establishment of allowance factors is a continuing exercise and allowance factors may change over time, resulting in an increase or decrease in the amount of the provision or allowance based upon the same volume and classification of loans.

Changes in allowance factors or in management's interpretation of those factors will have a direct impact on the amount of the provision, and a corresponding effect on income and assets. Also, errors in management's perception and assessment of the allowance factors could result in the allowance not being


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adequate to cover losses in the portfolio, and may result in additional provisions or charge offs, which would adversely affect income and capital. For additional information regarding the allowance for loan losses, see the "Asset Quality" section of this annual report.

Other-Than-Temporary Impairment-Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) the structure of the security. A decline in the market value of any available for sale security below cost that is deemed other-than-temporary results in a charge to earnings and establishment of a new cost basis for that security.

Goodwill and Other Intangible Assets-Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed related to the acquisitions of Maryland Bankcorp and WSB Holdings. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in these transactions. The core deposit intangible is being amortized over 18 years for Maryland Bankcorp and ten years for WSB Holdings and the estimated useful lives are periodically reviewed for reasonableness.

Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset's fair value. The goodwill impairment analysis is a two-step test. The first step, used to identify potential impairment, involves comparing the reporting unit's estimated fair value to its carrying value, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill assigned to that reporting unit is considered not to be impaired. If the carrying value exceeds estimated fair value, there is an indication of potential impairment and the second step is performed to measure the amount of impairment of goodwill assigned to that reporting unit.

If required, the second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated impairment. The implied fair value of goodwill is determined in a manner similar to the amount of goodwill calculated in a business combination, by measuring the excess of the estimated fair value of the reporting unit, as determined in the first step, over the aggregate estimated fair values of the individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination. If the implied fair value of goodwill exceeds the carrying value of goodwill assigned to the reporting unit, there is no impairment. If the carrying value of goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. An impairment loss cannot exceed the carrying value of goodwill assigned to a reporting unit, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted. We have determined that Old Line Bancshares has one reporting unit.

We engaged an external valuation specialist to assist us in the goodwill assessment performed at September 30, 2013, our annual test date, and determined that no impairment charge was necessary. Fair value of the reporting unit in 2013 was determined using three methods, one based on the prices paid for common shares of reasonably similar publically traded companies, another based on the prices paid for acquisition of control of reasonably similar companies, and lastly, a third method based on discounted cash flow models with estimated cash flows based on internal forecasts of net income. These three methods provided a range of valuations that we used in evaluating goodwill for possible impairment. Additionally, should Old Line Bancshares' future earnings and cash flows decline and/or discount rates increase, an impairment charge to goodwill and other intangible assets may be required. There have been no events subsequent to the September 30, 2013 evaluation that caused us to perform an interim review of the carrying value of goodwill.

Business Combinations-Accounting principles generally accepted in the United States (US GAAP) requires that the acquisition method of accounting, formerly referred to as purchase method, be used for


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all business combinations and that an acquirer be identified for each business combination. Under US GAAP, the acquirer is the entity that obtains control of one or more businesses in the business combination, and the acquisition date is the date the acquirer achieves control. US GAAP requires that the acquirer recognize the fair value of assets acquired, liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date.

Acquired loans-These loans are recorded at fair value at the date of acquisition, and accordingly no allowance for loan losses is transferred to the acquiring entity in connection with purchase accounting. The fair values of loans with evidence of credit deterioration (purchased, credit-impaired loans) are initially recorded at fair value, but thereafter accounted for differently than purchased, non-credit-impaired loans. For purchased, credit-impaired loans, the excess of all cash flows estimated to be collectable at the date of acquisition over the purchase price of the purchase credit-impaired loan is recognized as interest income, using a level-yield basis over the life of the loan. This amount is referred to as the accretable yield. The purchased credit-impaired loan's contractually-required payments receivable estimated to be in excess of the amount of its future cash flows expected at the date of acquisition is referred to as the non-accretable difference, and is not reflected as an adjustment to the yield, in the form of a loss accrual or a valuation allowance.

Subsequent to the acquisition date, management continues to monitor cash flows on a quarterly basis, to determine the performance of each purchased, credit-impaired loan in comparison to management's initial performance expectations. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior provisions, or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.

Acquired performing loans are accounted for using the contractual cash flows method of recognizing discount accretion based on the acquired loans' contractual cash flows. Acquired performing loans are recorded as of the purchase date at fair value. Credit losses on the acquired performing loans are estimated based on analysis of the performing portfolio. A provision for loan losses is recognized for any further credit deterioration that occurs in these loans subsequent to the acquisition date.

Income taxes-The provision for income taxes includes taxes payable for the current year and deferred income taxes. We determine deferred tax assets and liabilities based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which we expect the differences to reverse. If needed, we use a valuation allowance to reduce the deferred tax assets to the amount we expect to realize. We allocate tax expense and tax benefits to Old Line Bancshares and its subsidiaries based on their proportional share of taxable income.

Average Balances, Yields and Accretion of Fair Value Adjustments Impact

The following table illustrates average balances of total interest earning assets and total interest bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders' equity and related income, expense and corresponding weighted average yields and rates. Non-accrual loans are included in total loan balances lowering the effective yield for the portfolio in the aggregate. The average balances used in this table and other statistical data were calculated using average daily balances.


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                     Average Balances, Interest and Yields

                                                    2013                                     2012                                    2011
                                       Average                                  Average                                 Average
Twelve Months Ended December 31,       balance         Interest     Yield       balance        Interest     Yield       balance        Interest     Yield
Assets:
Federal funds sold(1)              $     3,582,839   $      3,851     0.11 % $   4,160,808   $      6,028     0.14 % $   4,511,838   $      6,088     0.13 %
Interest bearing deposits                  105,513            184     0.17       4,366,490         10,957     0.25      11,617,100         35,954     0.31
Investment securities(1)(2)
U.S. Treasury                            1,279,948          3,218     0.25       1,248,731         10,202     0.82         951,656          7,665     0.81
U.S. government agency                  39,298,327        569,019     1.45      27,322,439        383,208     1.40      17,015,717        351,399     2.07
Mortgage backed securities              72,334,100      1,464,994     2.03      88,403,848      2,243,209     2.54      85,595,192      2,635,172     3.08
Municipal securities                    62,484,076      2,896,472     4.64      48,479,618      2,465,949     5.09      19,232,924      1,100,704     5.72
Other equity securities                  4,297,264        259,738     6.04       3,879,785        193,516     4.99       3,443,591        128,679     3.74


Total investment securities            179,693,715      5,193,441     2.89     169,334,421      5,296,084     3.13     126,239,080      4,223,619     3.35


Loans:(1)
Commercial                             110,993,664      5,222,223     4.70      99,059,441      4,861,281     4.91      96,395,235      5,208,608     5.40
Mortgage real estate                   626,060,637     34,980,352     5.59     456,291,701     28,637,163     6.28     348,392,803     21,994,769     6.31
Consumer                                 9,982,711        678,167     6.79      12,800,542        775,485     6.06      14,741,474      1,400,154     9.50


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